Basel liquidity regulation and credit risk market perception: evidence from large European banks

Following the recent financial crisis, the Basel Committee on Banking Supervision (BCBS) undertook a negotiation process that led up to a liquidity reform package known as the new Basel III liquidity framework. This paper aims to assess the impact of BCBS liquidity regulation announcements on bank creditors. Using an event study on Credit Default Swap (CDS) data of large European banks over the 2007-2015 period, we find evidence that creditors increased expectations of a credit event following the regulatory events, with CDS spreads widening. Results also show that creditors were less sensitive to liquidity regulation announcements in banks with higher capital and liquidity funding ratios. In contrast, creditors were more sensitive in banks with higher bad loans, even though such effect is positively moderated by provisions against loan losses. We conclude that if banks correctly adjust the quality and the mix of their assets and liabilities, they could limit the potential side effects of Basel III liquidity regulation.